Question

Homeplate Lexi Taylor looked out the window of her Rexburg apartment and marveled at how her life had changed in the past few months. Since launching Homeplate a little over a year ago, she had grown from a one-person operation preparing meals in the local YMCA kitchen to a fast growing meal preparation and delivery service, with nearly 3,000 regular customers and strong growth and profit potential. Lexi had gone through raising a seed round of capital and was now considering a Series A investment from Eastern Idaho’s most prestigious venture capital firm, Potato Rock Partners. Not only had Lexi achieved success in her first venture, her personal life was going well with her recent engagement. With the wedding coming in December, Lexi had a lot to think about. Getting Started Lexi had a passion for good food and felt that she could share that passion with people who don’t want to dine out every night and who don’t have time to prepare good home cooked meals. Homeplate had entered the exciting new market of gourmet food shipped overnight ready to prepare. This value proposition appealed to working couples who wanted high quality food but did not want to purchase large quantities of expensive ingredients and did not have time to cook at home, but who did have enough income to pay more for a meal to be delivered to their homes. To get started, Lexi used $1,000 of her own money to buy supplies and equipment. She found a commercial kitchen at the local YMCA where she could prepare meals and take them to customers in elegant aluminum packaging. She issued herself 100,000 shares for her investment because it seemed like a reasonable thing to do. So, as she got under way, Lexi was able to retain control of her company and avoid the complications of finding co-founders and investors. Financing the Venture As the company grew, Lexi realized she was on to something special. She found an angel investor who was willing to invest $50,000 to help finance her growth. The investor wanted to buy shares for $0.50 per share. Lexi wasn’t sure if $0.50 per share was a good price or not for her company. She had put a lot of work into it herself and wanted to make sure she was capturing as much of the value she had created as possible. Suppose her company was worth closer to $2.00 per share. Lexi expected to have to raise an additional $300,000 in about a year. At that time, she also anticipated the price per share to reach $2.50 at that round. She wanted to understand how the price per share in the angel round would affect her ownership percentage when she raised the next round of investment. An Alternate Approach Lexi had heard of a form of investment called convertible debt. She wasn’t’ sure what it was or how it worked, so she watch a youtube video on the subject that helped clear things up somewhat. She learned that if she and her angel investor cannot agree on a valuation of the firm, but they still want to proceed with their partnership, the angel can issue convertible debt. This form of investment had the advantage of allowing the entrepreneur to raise outside capital without having to establish a valuation while revenues were small and risk still high. The angel benefitted from liquidation preference – if things went poorly the angel would get her money back before Lexi would be able to receive any funds from the venture. At the Series A round of financing, a firm valuation is established. At that time, the convertible debt converts to equity, usually at a discount to the share price of the Series A. This means when the debt converts, the price per share is discounted, allowing the angel investor to purchase more shares for the same amount of money. Additionally, any interest that may have accrued is usually added to the principle balance and converts along with the initial loan amount. Lexi wondered what effect convertible debt would have on her ownership, that of her angel investor, and future investors Potato Rock.

1.a. Create a capitalization table for Homeplate at the time of the initial founding of the company. Include the number of shares, price per share, total investment, and what percentage of the firm Lexi owned.

1.b. Create a capitalization table for Homeplate assuming that the angel investor invests $50,000 at $0.50 per share. Assume that Lexi issues new shares to the investor, so she retains her original 100,000 shares. How many shares would the angel purchase under this proposal? What share of the equity would Lexi own? What share would the angel own?

2. Create a capitalization table for Homeplate assuming that the angel investor invests $50,000 at $2.00 per share. How many shares would the angel purchase under this proposal? What share of the equity would Lexi own? What share would the angel own?

3. Assuming Lexi and the angel agreed on $1.00 per share in the seed round, what share of the company would she own after series A, assuming she raises $300,000 at $2.50 per share? What share of the company would the Angel own? Potato Rock?

4. Create a capitalization table for Lexi’s venture after raising her Series A funding using the following assumptions: a. Lexi chooses $50,000 convertible debt instead of equity for the angel round of financing (hint: NO equity is issued during the seed round) b. The convertible debt carried a 0% interest rate c. Lexi will raise an additional $300,000 at $2.50 per share in one year d. The debt will convert at a 10% discount, meaning the angel investor will be able to convert her debt into equity for 10% lower price per share than the Series A investors will pay.

5. How does the convertible debt affect Lexi’s ownership share of her firm? How is the angel’s share affected? The Venture Capital firm?

6. Which option should Lexi choose for the seed round based on your analysis?

Answer 1

Solution:

1a	Status at the time of initial funding
	No of shares	100000
	Price per share (USD)	0.01
	total investment	1000
	Lexi ownershiip %	100%
1b	Angel invests $50000 at $0.5 per share
	Angel will receive	100000	nos of shares
	Lexi	100000	nos of shares
	Ownership % post Angel investment
	Angel	50%
	Lexi	50%
2	Angel invests $50000 at $2 per share
	Angel will receive	25000	nos of shares
	Lexi	100000	nos of shares
	Ownership % post Angel investment
	Angel	20%
	Lexi	80%
3	Angel invests $50000 at $1 per share
	Angel will receive	50000	nos of shares
	Lexi	100000	nos of shares
	Further, she raised $300000 at $2.5 per share
	Potato share	120000	nos of shares
	Ownership % post Potato investment
		No of shares	% ownership
	Potato share	120000	44%
	Angel	50000	19%
	Lexi	100000	37%
		270000
4 & 5	Angel investment in convertible debt, Initially it won't impact the shareholding
	On raise of additional $ 300000 @ $ 2.5 per share
	Angel will get shares @ 10% discount of price quoted for series investor
		No of shares	% ownership
	Potato share	120000	44%
	Angel	22222	8%
	Lexi	100000	37%
		242222
6	Lexi should choose the option offered in question no 4